The Market Looks Good Until It Doesn't
We enter the meat of the earnings season with a set of mixed signals. The tech-heavy Nasdaq continues to outpace, while the rest of the major indices have gotten into somewhat of a funk.
Good earnings reports this week from Intel, Yahoo and EBay, coupled with high expectations for Google's quarterly release this Friday, have contributed to the outperformance. In contrast, the financial sector, along with any stock that has any perceived correlation to housing, continues to get battered.
Readers are aware that I have been writing about these discrepancies for more than a month now and the questions still remain. How long will this go on before something gives? I don't think much longer as I continue to see further deterioration in market internals and it seems like this Subprime problem is not over yet.
In this week's look at the charts, I'm going to do something a little different. First, we'll look at the daily time (below).
What's discernable from looking at this chart is that the primary trend is still higher. In it, there are a series of higher highs and higher lows and it's still trading above the 50-day exponential moving average. Notice how the EMA at [819.85] provided the support for the intraday reversal (more on this later).
In comparison, the hourly chart below, gives us an entirely different outcome. Here we have an illustration of a classic downtrend.
In this example, we have a sequence of lower prices. Also, note that the rally into resistance failed, which is typical of a decline.
Next, we're going to take a snapshot of the 5-minute time frame (below).
There are several observations I'd like to focus on here: The first is the gap opening which was the pre-market reaction to the consumer price index on Wednesday. Secondly, the gap was filled and traversed in the first half of the trading session. And finally, the ER2 made a huge intraday reversal in the last hour and a half of trading.
My purpose in showing you these distinct time frames is to demonstrate that there may be several trends happening simultaneously within one market ( in this case the ER2).
As a trader, you need to be cognizant of what the market is doing in all time frames, regardless of your style of trading. I find novice traders become myopic in the way they view the market, and by doing so, fail to spot good trades, and/or make bad ones.
Let me give two examples using the three charts we've reviewed earlier: In the first example, a trader is scouting for a low risk entry to short the market. In looking at the 5-minute chart, he knows the ER2 will be opening with a big gap up. He glances over to his hourly chart and notices the ER2 has been trending lower for the last four days. It's butting right up against the 30 period EMA that also happens to be the close (resistance) from two days ago. He's aware that he will have to risk very little to be proven wrong and that the reward could be handsome if he's right. In hindsight, that trade obviously worked, but my point is this: if he had not taken into consideration the larger time frame, he probably would have failed to recognize that opportunity. Or worse; he may have gotten caught up in the excitement of the opening rally and bought the ER2 for a losing trade.
In the second example: This trader has missed entering the market during the entire morning session. She's watching the market closely to see if the market will reverse. In looking at her 5-minute chart, she astutely detects that at 11:30 a.m. PST (because she trades on the West Coast) the ER2 makes a higher low than the day's low, which was put in at 11:00 a.m. She then pulls up her daily chart and discovers that the ER2 had just bounced off the 50 day EMA and that it's in a three month uptrend. She goes long on the ER2 and well … we know it also worked. In the same way as our other trader, she was able to find a low-risk high-reward trade by not neglecting the bigger picture. If you use the smaller time frames as "triggers" and longer time frames as "filters", you can open up a good number of possibilities. I'll elaborate further on this concept in future newsletters.
In summary: Market volatility has been picking recently, which makes for very fun trading days. However, with the increase in volatility comes higher risk, so traders need to make those all-important adjustments. We have the Philly Fed on Thursday and Big Ben giving a speech on Friday. What we have now is a bifurcated market; the Nasdaq still looks good, but the rest of the market is a bit more tenuous. I‘m still in the bull camp at this juncture, but it won't take much to persuade me to go short.
So until next time, I hope everyone has a profitable week.
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Gabe Velazquez is a professional
trader with 14 years of experience. His focus is intra-day and swing trading the
ER2 (Russell 2000 e-mini) using technical analysis as his primary tool. Gabe has
managed both stocks and futures accounts as well as conducted educational seminars
on technical analysis for the past ten years. He is a frequent guest on Biz radio,
where he shares his market knowledge and utilization of technical indicators.
Gabe also teaches the